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paper—is way too skinny compared to history. For
example, the fair value of 10-year US Treasuries
is around 2.7 per cent, some way below the 2.36
per cent yield at which they traded on
6 October. The US bond market is not even the
most expensive. Euro and UK securities are more
overvalued, and so are Japanese Government
bonds.
In the Cycle component, we pit our own
assessment of the near-term growth and inflation
prospects against what is priced in by the market
consensus. In the US, the Eurozone and the UK,
that comparison leads us to a negative view of
long-dated bonds. After the last six months,
when most investors were surprised by how low
inflation turned out, we believe that a gradual
turnaround in the price outlook is likely and
should exert upward pressure on bond yields.
The exception to that view is Japan, where the
central bank’s theoretically unlimited purchases to
keep 10-year yields around zero trumps all other
considerations.
Lastly, the Sentiment component, in which we
weigh up the momentum of an asset class against
the risk of a trend reversal, is also unfavourable
for government bonds. Our technical indicators
suggest that sovereign securities are somewhat
‘overbought’ in the short term, which is a
negative, while longer-term momentum is at best
neutral.
SYNCHRONISED TIGHTENING
Our CVS process demonstrates that the path of
least resistance for global bond yields is higher.
Investors have undoubtedly heard warnings of
the potential adverse effects of withdrawing QE
before. What strikes us is the synchronised nature
of central bank behaviour as we head into next
year. While the Fed was a lonely figure when it
tightened policy for the first time in late 2015, it
now has some company. Its Canadian counterpart
started later, but is now hiking interest rates at
a faster pace than the Fed. The Bank of England
strongly hinted at an increase in its base rate
before the end of the year. Across the English
Channel, the ECB is pondering whether to take
away some of the QE punchbowl before the party
gets too rowdy.
And despite their comparatively high yields,
Australian Government bonds are not likely to
decouple from the forces that shape global fixed
income markets.
Van Luu is head of currency and fixed income
strategy at Russell Investments.
Superfunds November 2017